Greg Mankiw’s column in Sunday’s New York Times makes the case that competition between governments is a good thing, that it makes them more efficient in the same way that competition among firms does. He paints it as also being about choosing re-distributionist policies or not, with Brad DeLong and Harold Pollack both ably making the case that of course governments should engage in redistribution.

As author of Competing for Capital, however, I am more interested in the question of whether government competition for investment leads to more efficient outcomes. The answer, in short, is that it does not. Indeed, competition for investment leads to economic inefficiency, heightened income inequality, and rent-seeking behavior by firms (a further cause ofinefficiency).

Mankiw claims:

…competition among governments leads to better governance. In choosing where to live, people can compare public services and taxes. They are attracted to towns that use tax dollars wisely….The argument applies not only to people but also to capital. Because capital is more mobile than labor, competition among governments significantly constrains how capital is taxed. Corporations benefit from various government services, including infrastructure, the protection of property rights and the enforcement of contracts. But if taxes vastly exceed these benefits, businesses can – and often – move to places offering a better mix of tax and services.

Mankiw doesn’t stop to think about what this competition looks like in the real world. To attract mobile capital, immobile governments offer a dizzying array of fiscal, financial, and regulatory incentives to companies in sums that have been growing over time for U.S. state and local governments, as I document in Competing for Capital and Investment Incentives and the Global Competition for Capital. His discussion centers on the reduction of corporate income tax rates, which is surely a part of the competition, but which is no longer an issue when an individual firm is negotiating with an individual government.

At that level, the issues then become more concrete: Can we keep our employees’ state withholding tax? Can we get out of paying taxes every other company has to pay? Will you give us a cash grant? The list goes on and on. As governments make varying concessions on these issues, you then begin to see the consequences: discrimination among firms (especially to the detriment of small business); overuse and mis-location of capital as subsidies distort investment decisions; a more unequal post-tax, post-subsidy distribution of income than would have existed in the absence of incentive use (a corollary of the fact noted by Mankiw that “capital is more mobile than labor”); and at times the subsidization of environmentally harmful projects. Moreover, many location incentives are actually relocation incentives, paying companies at times over $100 million to move across a state line while staying in the same metropolitan area, with no economic benefit for the region or the country as a whole (Cerner-OnGoal, now in Kansas rather than Kansas City, is a good case in point).

Once upon a time, about 50 years ago in this country, companies made their investment decisions based on their best estimate of the economic case for various locations without requesting subsidies. On the rare occasion when a company did ask for government support, it was at levels that would appear quaint today. For example, when Chrysler built its Belvidere, Illinois, assembly plant in the early 1960s, it asked for the city to run a sewer line out to the facility–and it even lent the city the money to do it.

Today, companies have learned that the site location decision is a great opportunity to extract rents from immobile governments, and invest considerable resources into doing just that. An entire industry has sprung up to take advantage of businesses’ informational advantages over governments–and, indeed, intensify that asymmetry–to make rent extraction as effective (not “efficient”!) as possible.

Finally, let’s reflect on the force that makes this process happen, capital mobility. The fact that capital has far greater ability to move geographically than labor does, and that governments of course are geographically bound to one place, is a source of power for owners of capital. Modern economists, especially conservatives and libertarians, often have great difficulty acknowledging the role of power in market transactions, though their ostensible hero, Adam Smith, did not. To treat this power as a natural phenomenon rather than a social one, as Mankiw does, is dangerously close to saying that might makes right. But that’s not the way things are supposed to work in a democratic society, or a moral one.

Comments (18)

Ogden Wernstrom

April 22, 2012 10:58 am

I think a factor in this is that the companies are buying votes.

I live in a county that gave long-term tax breaks to a computer-chip manufacturer when their first plant was built here, and that company has pretty well locked-in that precedent of long-term tax breaks for every capital project in the past 20+ years. (I’m told that the value of some of these tax breaks was fixed at inception, and that assets which have been retired still generate tax credit while their replacements generate an additional tax credit.)

There are enough employees now working for this manufacturer that no elected politician would dare to stop the subsidy. Everyone knows someone who works either directly or indirectly for that company, and each time there is a new capital project to exclude from the tax rolls we are reminded that they are trying to decide which would be the best location for this new building/plant/process/machinery….

The subsidies also allow this company to be fairly generous with employees, giving it a good reputation at street level.

Min

April 22, 2012 11:37 am

“To treat this power as a natural phenomenon rather than a social one, as Mankiw does, is dangerously close to saying that might makes right. But that’s not the way things are supposed to work in a democratic society, or a moral one.”

Homo economicus is neither democratic nor moral.

Steve Roth

April 22, 2012 11:38 am

I’ve long pondered ways whereby we could short-circuit the negative-sum effect of jurisdictions competing for businesses and investment. A Government Corrupt Practices Act? I can’t see that working, but would love to hear ideas that might.

Min

April 22, 2012 11:47 am

If firms compete for customers, presumably that competition benefits customers at the expense of the firms. (Not that things are zero sum.) If gov’ts compete for citizens, presumably that competition benefits citizens at the expense of the gov’ts. But if the gov’ts are democracies, then the expenses of the gov’ts are passed on to their citizens. There is no obvious advantage or disadvantage. If gov’ts compete for corporations, presumably that competition benefits corporations at the expense of the gov’ts. The corporations, although persons, are not citizens, so the loop stops there.

coberly

April 22, 2012 12:42 pm

This argument is old. The trouble is that you are not arguing with honest people. Or sane. And the other trouble is that Mankiw gets the New York Times, and you get Angry Bear.

The “competing for business” is a con game, or graft. And therefore it will continue.

Jack

April 22, 2012 1:12 pm

“Corporations benefit from variousgovernment services, including infrastructure, the protection ofproperty rights and the enforcement of contracts. But if taxes vastly exceed these benefits, businesses can – and often – move to places offering a better mix of tax and services.”

Those words are the opinion of a corporatist sycophant not an objective economic observer. It is no surprise that they would appear in the NY Times, a news paper with a schizoid character. At one moment acting the objective reporter, but only for a moment. And for the rest of the day’s moments playing the role of publicist for the corporate class and their sycophants.

As I noted in my posting. Bernie Sanders has suggested removing federal money sent a state that gives tax breaks etc to a company for relocating.

Stop the states (there are only 50 of them), it’s that simple.

He has also suggested a similar remedy when a state sales it’s infrastructure. Make the state reimburse the federal government for it’s share of the money used to build the sold asset.

Both are appropriate remedies as the Fed money used is from all 50 states. When a state does a give away, the Fed I’m sure is on the hook for the loss in the prior state of the company (unemployment, reduced state tax collections etc) and the new state loss of revenue do to the give away. Thus, you have the entire country paying for one states actions.

Stop the states and it all ends.

Daniel Becker

April 22, 2012 4:16 pm

The error in thinking for Mankiw and his school of thought is that the argument always starts from a position that all relationships are a market relationship. Thus, to Mankiw et al, a market is an economy and an economy is a market. This makes every entity an “agent” within the market. Thus, governments are nothing more than another player in the market.

Of course, specifically we have heard that governments need more business orientation to their policy. Romeny and Bush, the “business” president. Such an argument is simply an extention or appendage of what Mankiw is presenting.

Anyone of position on the national media stage that takes issue with Mankiw et al, needs to start from a position well before the one of Mankiw et al; that government makes the eonomy, especially in a system of governance such as ours but, even with a dictator or royalty. Government is not an agent within the market. Government can not be properly or honestly view or interpreted as such.

From a position that government is the creator of the economy, Mankiw” entire argument crumbles. Whether local or state, they are all sub sets of the federal created economy. To treat govenment as players in the market is to give up the government authority to dictate the purpose and thus the type and ultimately the results produced by the economy.

IOW, to argue as Mankiw does, is to remove the prime power of government which creates an economy: Regulation. Regulation is exactly what the conservative/libertarian want removed. Now we can understand his and those who think as him when he states:Because capital is more mobile than labor, competition among governments significantly constrains how capital is taxed.

To argue from a position of government as a player in the market is to also remove government from it’s other proper roll within an economy: the counter market force. Not to view government in this proper roll is to allow the acceptance of “austerity”. The failure of “austerity” policy is ultimately the result of this failure in thinking (intentional or other wise).

None of this is to say that government at times can not act as a player in the market. The public sector is the government acting as a player in the market. How much of a player is determined by voting. Currently voting is done by two means: casting a ballot or funding a campaign (election or otherwise). To the extent that government is restrained as a player within the market determines the purpose and thus results of the economy.

Restraining of the government could be that it is not allowed to make shoe, but instead can buy shoe or not be allowed to effect anything related to shoe making, buying or selling. In this is government setting and making the economy, specifically the sub set of shoes.

Which gets us back to Mankiw and government as a player/business. Once government is viewed as a business then it follows that government should be promoting business favorable policy exclusively. Being that business these days is currently nothing more than making money from money, it only follows that government should allow business to make money from the government’s money and now we have arrived at government giveaways and competition among government for business.

Mankiw et al’s thinking is the sickness of a selfish mind. It is this mind that is continuously pushing to remodel government in it’s likeness.

Daniel Becker

April 22, 2012 4:19 pm

Let me just add, that between my post and this post by Ken it should now be obvious that the issue is no longer the corporate tax rate or capital gains rate. The issue is that capital is slowing moving government such that it will no longer pay any tax of any kind. And, they are doing this will reducing the ultimate tax base: Wages.

This is not Norquist starve the beast in action. He’s just the side show. No, this is far worse.

save_the_rustbelt

April 22, 2012 4:59 pm

Once upon a time the economy was so healthy that states were not so inclined to claw and scratch for every job.

Until that reappears the states are going to give incentives and no amount of blogosphere complaining will change it.

Daniel Becker

April 22, 2012 5:31 pm

Well, yes, it is true that chasing the effiency of money which is materialized in the consolidation of a market sector behind the motto of “efficiencies of scale” is one of the reasons business is in a position to play one government over another in this nation.

The government acting in it’s proper roll of economy maker used to assure massive amounts of competition via regulations such as the anti trust laws.

PJR

April 22, 2012 5:49 pm

Once upon a time the federal government gave some priority to low unemployment rates. Mankiw likes to assume that jobs are a scarce commodity, because he likes it that way. When jobs are scarce, governments are far more likely to compete for them and the winners are corporations. Mankiw might as well say that corporations win when they don’t have to compete for labor, but labor has to compete for them–sometimes via their governments.

Noni Mausa

April 22, 2012 6:49 pm

To the argument “If we tax the rich they will leave,” why does no-one ask “What is their citizenship? Where will they raise their children? What do they own that they are threatening to take from us, to our ackowleged hurt, and why isn’t that seen as the threat or, if carried out, the injury it is?”

The threat is, “If you don’t let us use the employees who are your citizens as we please, we will cut off their source of sustenance altogether.”

Yet without people to work for them — and buy from them — they cease to exist altogether. Who should be threatening who?

coberly

April 22, 2012 8:06 pm

Rusty

no doubt. but as others here are pointing out, it is a fools game. the “governments” are being played, or bought.

there are lots of ways good government can attract business… as by the advantages that come from living and doing business in an honest and well run “state.” but Mankiw and friends are only interested in cutting taxes for the sake of cutting taxes. i have heard people say, who know, that no company locates based on taxes… there are other more important considerations. But they’ll take the tax cuts if they can get em… and march with “the government” down the spiral of cutting “costs” below what is needed to get a quality product, or a decent place to live.

Kenneth Thomas

April 23, 2012 3:45 am

I think location theory needs to be modified to make rent-seeking and bargaining power central to the equation. Yes, you’ve got to find an economically feasible location first, but for any given investment there are a lot more than there used to be due to capital mobility.

coberly

April 23, 2012 11:02 am

Min

i think you reveal the flaw in the logic:

if firms compete for customers…that benefits the customers at the expense of the firms.

so then why do the firms compete?

but when governments “compete” for business, you are not looking at the same dynamic. you are looking at a neurotic transaction where one party, the loser, is progressively degraded into giving up more and more of his/her real worth in order to “earn” the cheap notice of the false lover who enjoys degradation of others for its own sake.

coberly

April 23, 2012 11:06 am

kenneth

perhaps… if i understand you… but this is the sickness we were warned about worshipping mammon.

once you reduce life to a few extra dollars more or less money, you inevitably reduce the quality of life to where it isn’t worth living, for either the rich or the poor.